Definition of Managerial Economics

Application of economic theory and the tools of analysis of decision science to examine how an organisation can achieve its aims or objectives most efficiently

The Nature of Managerial Economics Management Decision Problems

Economic Theory (Micro and Macro Economics)

Decision Sciences (Mathematics, Statistics, Econometrics)

Managerial Economics((Application of Economic Theory and decision science tools to solve managerial decision problems Optimal Solution to Managerial Decision

Classification of Economic Theory

Micro Economics Macro Economics Important Concepts

Demand & Supply

Interaction between buyers and sellers

Importance of Demand:
A firm would not be established or survive if sufficient demand for its product did not exist Many firms go out of business soon after being set up because their expectations of a sufficient demand for their product fails to materialize even with a great deal of advertising.

Law of Demand
Law of Demand What is demand? Individual demand or market demand Significance of individual buyers in the market Economic laws - applicable more to the market than to the individual

Individual Demand for a Commodity

Qdx = f (Px, I, Py, T) Where Qdx = quantity demanded of commodity X Px = price of X Py = price of other related commodities ; y = 1,2,3 .n commodities T = taste and preferences of consumer I = Income of the Consumer

Individual Demand Schedule

Price of Peter England Shirts 150 275 475 Quantity Demanded of Peter England Shirts 6 4 1

Points to Remember
Law of demand treats the quantity demanded of a commodity as a flow concept Commodity measured in identical quality units Ceteris paribus

Demand Function
Population potential buyers in the market Income of consumers Prices of related commodities Consumers tastes and preferences Consumers expectations

From Individual Demand to Market Demand (Market Demand Schedule)

Price of PE Shirts QD of PE Shirts (Consumer A) 6 4 QD of PE Shirts (Consumer B) 5 3 Total QD of PE Shirts (A +B)

150 275

11 7

475

Market demand Schedule & Curve

Quantity Demanded of mango (Kgs/day) 100 120 140 160 180 Price of mango (Rs/kg) 12 10 8 6 4

Aspects to Examine
level or the distance from the two axes and the origin depend on other factors Shape nature of relationship Slope what is slope? curvature

QDx = F (Px, N, I, Py, T) Where

Market Demand Function

QDx = Quantity Demanded of X Commodity in the market Px = Price of X Commodity I = Total Income Py = Price of related commodities T = Tastes and Preferences

Attainable and non attainable areas in the demand curves

Contraction & Expansion in demand Increase or Decrease in Demand A combination of both role of managers

Bangwagon Effect To keep up with the Joneses Snob Effect

Case Study: The demand for Big Macs McDonald s Company with a nearly 43 per cent share of the 36 billion US fast food burger market and serving 23 million customers per day. Its closest rival Burger king hold 22 per cent of the US market. But after nearly three decades of double digit gains, domestic sales at Mc Donald s have been growing slowly since the mid 1980s as a result of higher prices, changing tastes, demographic changes and increased competition from other fast food chains and other forms of delivering fast foods. The price of hamburger increased from 15 cents to $4 and this sent customers to lower pricing competitors

Concern over cholesterol and calories also reduced the growth The proportion of the 15-29 years olds (the primary fast food customers) in the total population declined from 27.5% to 22%.

Competition increased from other fast food companies such Burger King, Wendys Availability of other fast food options such as pizza, chicken, tacos and so on

Solution Adopted by MCDonald

Mcdonald identified his loop holes and adopted the correction measures such as: -introduced small hamburgers at price as little as 59 cents in response to increased public concern about cholesterol and calories, MCdonald bean publicizing the nutritional content of its menu offerings, substituted vegetable oils etc. All these measures however failed to stimulate the growth and Mcdonald abandoned most of them and started expanding its business abroad where it faces much less competition

Types of Demand Direct Demand Consumer goods, major determinants are price and income Indirect Demand producer goods major determinants are demand for final consumption goods.

Derived Demand When a product derives its usage from the use of some primary product. Eg demand for tyres is derived from demand for vehicles Autonomous Demand Demand for the product that can be independently used the demand for milk or vegetables

Durable and Non-Durable Goods Demand Firm and Industry Demand reynolds pen and pens Total Market and Market Segment Demand

The extent to which these factors influence demand depends on the type/kind of good(s) Normal goods, Inferior goods, giffen good

Engel Curve for Normal Good What is Engel Curve?

I n c o m e Demand for Good X

Engel Curve for Inferior Goods

Engels Law

Case Study
Automobiles Riding High

Law of Supply

Factors affecting the level of Supply

Technology Input prices Government taxes and subsidies Prices of related goods Future expectations

Supply Schedule & Supply Curve

Quantity Supplied of mangoes kg/day 100 120 140 160 180 Price of mangoes (Rs/kg) 6 7 8 9 10

Attainable and non attainable regions

Supply above attainable and below nonattainable

Supply function
Contraction / expansion Increase / decrease

Equilibrium
Interaction of Demand & Supply Multiple equilibria Stable and unstable equilibrium

Price Determination
Supply Constant Demand Constant Shifts in demand and supply curves

Theory of Consumer Choice

Utility Analysis Maximize the satisfaction or utility he derives from consumption of the goods. How much of the good, say X, the consumer would purchase depends on what utility he derives from its consumption in comparison to the demand for consumer goods. Utility is thus basis for the demand for a commodity

Utility - How do we measure?

Two approaches Cardinal utility theory and Ordinal utility theory

Cardinal utility theory As per the Cardinal Utility theory, a consumer derives total utility (TU) from the consumption of several commodities like X, Y, Z. The total utility of a consumer is considered to be a function of his consumption of various commodities. TU = f (X, Y, Z) The cardinal utility theory assumes that the utility derived from different commodities are independent and that the utility function is additive in X, Y, Z etc. TU = TUx + TUy + TUz+ .+ TUn

Marginal Utility (MU)

MUn = TUn = TUn TU(n-1).

Relationship between TU and MU and the Law of Diminishing Marginal Utility

Units consume d
1

TUx
150

TUy
7200

MUx
150

MUy
7200

250

12600

100

5400

325

16200

75

3600

375

18900

50

2700

415

20700

40

1800

Conditions to Diminishing MU
1. the consumption of other goods do not change 2. the preference function of the consumer does not change 3. the units of good X are homogeneous in all respects 4. the time duration does not change.

Law of Equi- Marginal Utility . Let a consumer has a money income of Rs 5500/-. Let there be two commodities X and Y His utilities from the consumption of these goods are given in the table below Let the price of x is Rs 25 and price of Y is Rs 1800 per unit.

Marginal Utility of Money Spent on Goods X and Y (in Utils)

Units consumed

MUx

MUy

150/25 = 6

7200/1800= 4

100/25 = 4

5400/1800 = 3

75/25 = 3

3600/1800 = 2

50/25 = 2

2700/1800= 1.5

40/25= 1.6

1800/1800 = 1

Condition of consumer s equilibrium is: MUx/Px=MUy/Py=MUz/Pz= .MUn/Pn This is Law of Equi Marginal Utility

Derivation of Demand Curve from EquiMarginal utility

Demand Curve for Commodity X With price of X Rs 25/- and Y Rs 1800 and Income of Rs 5500 the maximum satisfaction he obtains by consuming 4 units of X and 3 units of Y. At Rs 25/- price of X he buys 4 units of X If the price of X falls to Rs 20/-

Units consumed

MUx

MUy

150/20 = 7.5

7200/1800= 4

2 3

100/20 = 5 75/20 = 3.75

5400/1800 = 3 3600/1800 = 2

50/20 = 2.5

2700/1800= 1.5

40/20= 2.0

1800/1800 = 1

The equilibrium quantities the consumer purchases are : 5 units of X and 3 units of Y. Another point in the demand curve